The plans, which will form part of a new price-cap regime from 2000, will also pile further pressure on water shareholders by pledging that bills will not increase in real terms in the years that follow the initial price reduction.
Mr Byatt said the next set of price controls would have to make up for efficiency gains made by companies in the current price regime, which began in 1995 and was due to last until 2005.
He has since decided to introduce a new formula from 2000 after several of the 10 big water and sewerage groups failed to meet their investment targets. In 1995-96 their capital spending fell short of the pounds 2.6bn target in the price formula by pounds 300m.
Mr Byatt said the water companies had "reported significant savings since the last review of price limits". He continued: "I propose to transfer the future benefits of these savings to customers at the next review through an initial downward adjustment of real prices."
Though Mr Byatt's department, Ofwat, has not fixed a figure for price cuts, it is taking a lead from the electricity and gas industries where recent price packages have provoked furious responses from the companies involved.
British Gas has taken its campaign against a 20 per cent one-off cut planned by the watchdog, Ofgas, to the Monopolies and Mergers Commission.
Ofwat also made it clear that water groups could not expect to see above- inflation increases in bills in later years, reversing the previous pricing policy which allowed the cost of the huge investment backlog in the industry to be passed directly through to customers.
David Luffrum, finance director of Thames Water, admitted the new formula would be "tough" to comply with. Thames was the only water company which recently refused Mr Byatt's request to soften price increases next year because its investment had not matched Ofwat targets.
"This is a nice objective but the reality has to be that it depends on the scale of the service improvements demanded. You can't have an open consultation process and prejudge the matter," Mr Luffrum said.
He said the final price cap must depend on whether the European Commission tightened controls on drinking water standards, requiring companies to make further investments. "If Europe conjures another shopping list of improvements then the process has to be flexible. Otherwise it would be unreasonable."
In another innovation, Mr Byatt is to appoint an advisory board of senior industrialists, mirroring a similar move by Don Cruickshank, the telephones regulator.
However, Ofwat said that this did not amount to the kind of non-executive board which the Labour Party had recently called for.